Describe Three Issues Or Problems A Company Could Encounter

Describe three issues/problems that a company could encounter when trying to determine the actual cost of a good or service to be used in the cost of goods sold

Determining the actual cost of a good or service is a fundamental aspect of financial management for any company, as it directly influences pricing strategies, profit margins, and financial reporting. However, companies often face several challenges that complicate accurate cost determination. Three significant issues include allocation of indirect costs, capturing hidden costs, and fluctuations in input prices.

First, the allocation of indirect costs poses a substantial challenge. Indirect costs, such as overhead expenses, are not directly traceable to a single product or service and must be apportioned across multiple cost centers. Misallocation can lead to inaccurate product costing. For example, manufacturing companies like automotive producers often allocate factory overheads, including maintenance and utilities, which may be difficult to assign precisely, particularly when production involves multiple simultaneous processes.

Second, capturing hidden costs presents another obstacle. Hidden costs include opportunity costs, waste, or inefficiencies not immediately reflected in direct expenses. For example, a technology startup might overlook the cost of delayed project delivery due to inefficient workflows, which can inflate the actual cost of a product or service when these inefficiencies are eventually addressed or result in lost revenue.

Third, fluctuations in input prices can significantly distort cost calculations. Costs of raw materials, labor, or energy can vary over time due to market conditions, supply chain disruptions, or geopolitical issues. For instance, oil-dependent industries such as transportation or shipping face volatile fuel costs; an increase in fuel prices raises their actual costs, impacting profit margins unless properly adjusted in cost calculations.

Factors Affecting Airline Industry's Ability to Break Even

The airline industry faces unique financial challenges that impact its ability to achieve breakeven. Based on the Zacks Investment Research article "Airline Industry Stock Outlook – August 2012," three primary factors influencing this capability are fuel prices, labor costs, and passenger demand fluctuations.

Fuel Prices

Fuel costs constitute a significant portion of an airline's operating expenses, often accounting for 30-40%. When fuel prices rise, fixed and variable costs increase substantially, reducing profit margins. Airlines traditionally use fuel hedging strategies to manage this risk; however, if fuel prices spike unexpectedly, the additional expenses directly impact contribution margins. Conversely, a decrease in fuel prices can enhance profitability by lowering variable costs. If fuel prices continue to fluctuate upward, airlines’ breakeven point shifts higher, necessitating increased ticket prices or cost-cutting measures, which may reduce competitiveness.

Labor Costs

Labor expenses, including wages, benefits, and pensions, represent a significant fixed cost for airlines. Sudden increases in labor costs—such as industry-wide wage negotiations or new regulatory requirements—raise fixed operating expenses. An increase in these costs makes it more difficult to reach breakeven unless airlines counterbalance with higher fares or increased passenger volume. Conversely, reductions in labor costs, perhaps through workforce restructuring or productivity improvements, can positively impact breakeven points by decreasing fixed costs. Fluctuations in labor costs therefore directly influence the overall cost structure and profitability prospects of airline companies.

Passenger Demand

Passenger demand influences revenue directly, impacting the contribution margin per flight. When demand drops due to economic downturns, geopolitical issues, or health crises, airlines struggle to fill seats, leading to lower revenues and higher fixed cost per passenger. This scenario increases the breakeven load factor—the minimum percentage of seats that must be filled to cover operating costs. Conversely, a surge in demand can reduce the breakeven threshold, enabling airlines to operate profitably at lower load factors. Thus, fluctuations in passenger demand profoundly affect airlines' ability to break even, with economic factors and external shocks playing a pivotal role.

Conclusion

Accurately determining the cost of goods or services requires overcoming challenges such as the proper allocation of indirect costs, capturing hidden or opportunity costs, and managing input cost fluctuations. Similarly, industry-specific factors like fuel prices, labor costs, and passenger demand significantly influence an airline's financial stability and ability to reach breakeven. Understanding and managing these issues are essential for strategic planning and sustainable profitability in competitive markets.

References

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• Gains, D. (2012). Managing indirect costs in manufacturing. Journal of Cost Management, 26(4), 20-29.
• Harrison, A., & Van Hoek, R. (2017). Logistics management and strategy: Competing through the supply chain. Pearson.
• Federal Aviation Administration. (2012). Industry financial reports. FAA Annual Reports.
• Zacks Investment Research. (2012). Airline Industry Stock Outlook – August 2012. Retrieved from https://www.zacks.com
• Gittell, J. H. (2003). The Southwest Airlines way: Using the power of relationship to achieve high performance. McGraw-Hill.
• SAA (South African Airways) Financial Analysis. (2011). Annual Reports. Retrieved from https://www.flysaa.com
• International Air Transport Association. (2012). Economic performance of the airline industry. IATA Economics Reports.
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